Using A Simple Moving Average To Determine Trend Direction

Today we are going to be looking at how we can put to use one of the most popular trading indicators to help us identify what the current trend is in the market.

Identifying what the current trend is for beginning traders can sometimes be a difficult process, which is why I thought I would share this simple method with you today.

Although I’m always going on about how indicators are worthless when it comes trading and how sticking to price action provides far better results, the way we’re going to be using the simple moving average is not for actually making trading decisions.

All indicators are considered worthless if they get used in the decision-making process when placing trades, this is not what we are doing, what we’re going to do is use an indicator to help us identify what trend the market is currently in, the indicator itself has no effect on our trading decisions, it’s just a quicker way to take one look at the chart and from a glance know which direction the market is currently moving in.

What Is A Simple Moving Average ?

The simple moving average in its most basic definition is an indicator which will draw a squiggly line on your chart.

Moving averages themselves are some of the oldest tools used in technical analysis.

In fact, the first recorded usage of a moving average in financial markets was way back in 1901, way before any computers were available, this means the traders back then had to manually calculate the prices which plotted the moving averages on the charts, no doubt this would have been an incredibly time-consuming process, we should be thankful for the invention of computers, otherwise market analysis would take so long we probably wouldn’t get a chance to place any trades

The way the simple moving average line is calculated is based on adding up the closing prices for whatever time period you want to see the average for.

For example, if i wanted to see the average price of the EUR/USD over the past 50 days I would put this in to the settings window of the simple moving average and once confirmed a line would be placed onto the chart showing the average price in the market for the past 50 days.

How To Place A Moving Average On Your Chart

Adding a simple moving average to your charts is very easy.

To add a moving average to your chart simply go to edit, found in the top left hand corner of MT4, scroll over indicators and click the option labelled ‘Moving Average’.

After selecting moving average from the list above, the settings window for moving averages will open.

There are a few different options we’re able to change in this box, for now the only one were interested in is ‘Period’.

Note:

In the settings window you can also see a box labelled ‘MA Method’.

This allows you to select which type of moving average you want to place on your charts, if the box doesn’t say ‘Simple’ make sure you change it, the other moving averages, while offering slight changes to the formula which calculates the averages are typically of no use to us.

The number we put into the box next to ‘Period’ will determine how long the average will be.

If we put 100 into this box ,the moving average that appears on our charts will be based on the average price in the market over the last 100 days.

For what we’re doing 100 days is a bit too long, we only need to see to half of that, so type 50 into the box then click OK at the bottom of the window.

Voila just like that you have a simple moving average on your chart.

With this now placed on your chart you’ll be able to know just from a quick glance what direction the market is currently trending in.

Observing which direction the simple moving average is pointing will give you some indication of how strong the current trend in the market is.

If you see the average start to flatten out, it’s giving you a ‘hint’ that the market may be about to enter a consolidation phase, this means you might want to start considering whether to switch to a different trading strategy as trend trading strategies tend not to work too well during times when the markets in a consolidation.

Summary

It’s important to understand that using a simple moving average for trend identification is not a superior method to using swing highs and swing lows, moving averages as with most indicators are lagging in nature, meaning the market will have to move up and down sufficiently enough in order for the simple moving average line itself to change.

This lagging nature of moving averages is what makes traders who use them for making trading decisions lose money.

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